A stock split will cause the share price to decline significantly. If you do not know a split is pending, the sudden drop in your share value can be a bit of a shock. However, a stock split does not change the total value of your stock position. You just end up with more shares, at a lower price per share.
Stock Split Mechanics
A stock split replaces the number of company shares outstanding with a larger number of shares. The corporate board of directors declares a stock split with the ratio of new shares to old shares. Typical split ratios include 2-for-1, 3-for-1, 3-for-2 and 5-for-2. If you own 100 shares of a company that declares a 3-for-1 stocks split, after the split you will own 300 shares.
Stock Split Math
A stock split does not change the total value of the shares an investor owns. Because the split results in more shares outstanding, the stock price declines by the ratio of the split. If before a 3-for-1 split the share price was $90, after the split the shares will start trading at $30. If before the split you owned 100 of the $90 shares worth a total of $9,000, post-split you would have 300 shares worth $30 each, and a total value of $9,000.
Why Stocks Split
A company declares stock splits to keep the share price in a range that its management thinks is attractive to investors. A very high share price limits the number of investors who are willing to buy shares. A vivid example is Wal-Mart, which declared 11 stocks splits over the 29 years after it went public in 1970. An investor with 100 shares of the company in 1970 ended up with more than 200,000 shares by the end of the century. Wal-Mart declared all those splits to keep the share price in a roughly $30 to $60 range.
Investment Value Effects
Although a stock split has no immediate effect on an investor's investment value in a stock, splits are generally viewed as positive. A board of directors usually will not declare a split unless it believes that the company's business is strong and the stock will continue to move higher. However, a split is not a guarantee of a higher stock price in the future. Base your investment decisions on your usual reasons to buy or sell a stock.
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